Loan costs soar as access tightens
— -- If the credit markets are truly the lifeblood between Wall Street and the economy, that artery suffered a major shock Monday.
Unnerved by the House of Representatives' unexpected blockage of the proposed $700 billion financial bailout plan, credit markets constricted further as investors got even pickier about to whom they would lend money and gravitated to only the safest borrowers, including the U.S. government.
The bond market's tightness is presenting businesses and consumers with dramatically higher interest costs and less access to loans, the last thing the economy needs as the global financial system slows.
"Credit is a lifeline to our economy. This is extremely serious," says Robert Gahagan, director of taxable bond investment at American Century Investments. "This will cause good firms to not have the ability to get credit."
The flight to safety was clear in the:
•Rush for government securities. The race into Treasuries, especially the ones considered safest because they mature the soonest, showed just how nervous bond investors have become.
Investors scrambled to buy the safest security they could find: three-month Treasury bills. The three-month yield sank to 0.14% from 0.87%. That's a big decline considering that the Treasury increased the supply Monday by selling additional securities, says Tom di Galoma at Jefferies. Investors also piled into 10-year Treasuries, pushing the yield down to 3.58% from 3.86%, the biggest decline since Sept. 15 after Lehman's collapse and Merrill Lynch's forced sale to Bank of America, Bloomberg News says.
On Tuesday, the yield on the 3-month T-bill recovered to 0.62% as the Dow Jones industrial average rebounded somewhat.
The T-bill yield is still very low by historical measures, however — particularly when compared to lending rates between financial institutions.
"It's been, 'Buy the safest asset you can: Treasury bills.' That's where everyone is hiding," di Galoma says. "Money is flowing out of stocks and into bills."
Banks also stayed in miser mode after a key bank-to-bank lending rate, the London Interbank Offered Rate, or LIBOR, soared to 4.05% from 3.88% for 3-month dollar loans, and to 6.88% for overnight dollar loans.
•Rising aversion to riskier companies' debt. Any company with even a hint of risk is seeing borrowing costs skyrocket. Companies with lower credit ratings, either because of their smaller size or weaker financial health, are paying 10.8 percentage points above Treasuries with equivalent maturities, according to the Merrill Lynch U.S. High Yield index.
Not only does that mean bond investors are pricing in distress among companies, but borrowing for these companies as a group is as costly as it's been since October 2002. "Expectations are for the default rate to keep moving higher in this weaker economy," says Wan-Chong Kung at FAF Advisors.
•Caution toward companies normally viewed as bulletproof. The value of bonds in the most highly rated U.S. companies has fallen 11% this year, on track for the worst year for them since 1994, says money manager Ken Winans of Winans International.
The credit market's reaction to the news boils down to one word, "panic," says Marilyn Cohen of Envision Capital Management. "However bad it is in the stock market, it's worse in the bond market."